Analysis

Opening PPP Loans To Bankrupt Ventures A Welcome Change

By Vince Sullivan
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Law360 (July 31, 2020, 4:08 PM EDT) -- Bankruptcy experts are applauding a proposed change to the Paycheck Protection Program that will allow small business debtors to access loans under federal COVID-19 relief packages, correcting what they say was a mistake in early versions of the aid program that left bankrupt companies without a valuable tool for surviving the pandemic.

Previously barred from even applying for the loans backed by the Small Business Administration, debtors would be able to seek and receive loans of up to $10 million with approval of the bankruptcy court in a move that Shane G. Ramsey of Nelson Mullins Riley & Scarborough LLP said will likely save many businesses struggling in the midst of the coronavirus outbreak.

"The prior law resulted in having absurd results," Ramsey told Law360. "I think the change is a needed change and a very good change to the law."

Those absurd results included having a company apply for and be approved for a PPP loan, and then filing for bankruptcy soon after, as well as having current debtors voluntarily dismiss their insolvency proceedings, applying for the loan and then refiling a bankruptcy petition. Blue Ice Investments LLC took such an approach in Arizona bankruptcy court earlier this year, as did Eastern Niagara Hospital in New York and Faith Community Health System in Texas.

A decision from a Texas bankruptcy judge in April approved an injunction against the SBA prohibiting the agency from denying a PPP loan to debtor Hidalgo County Emergency Service Foundation. The court's ruling said the SBA exceeded its authority by adopting the rule barring debtors from obtaining the loans when no such prohibition was included in the legislation.

On appeal, the Fifth Circuit overturned the injunction based on a part of federal law that prohibits all injunctions against the SBA. Other courts have issued conflicting ruling in recent months, leaving the fate of debtors in need of PPP loans in doubt.

Jared Ellias, a law professor at the University of California, Hastings, said a group of legal scholars has lobbied Congress for changes to the bankruptcy system during the pandemic to assist companies with reorganization efforts. Dubbed the Bankruptcy and COVID-19 Working Group, he said its efforts included pushing for debtors' ability to participate in the trillions of dollars in stimulus and aid packages that have been advanced since March.

"There was never any good reason why the CARES Act lending program shouldn't be available for Chapter 11 firms," Ellias told Law360. "The bankruptcy system is kind of the economy's standing hospital for helping financially distressed companies and people. It made no sense for distressed firms to choose between PPP loans and bankruptcy."

When President Donald Trump signed the $2.2 trillion Coronavirus Aid, Relief and Economic Security Act, or CARES Act, in March, it included $349 billion in funding for the PPP that created the loan program administered by the SBA. Eligible small businesses could apply with participating banks for loans guaranteed by the SBA to help fund payroll, mortgage and utility expenses during the economic crisis created by the spread of the coronavirus. If the loans are spent by the borrowers on appropriate expenses, then they will be forgiven. If not, they become due after a year at a 1% interest rate.

The initial round of funding ran out in about two weeks, and congress authorized an additional $310 billion for the program. As of July 28, the PPP has handed out $520 billion of loans to more than 5 million businesses, according to the SBA.

The changes to the PPP were floated in a proposal from U.S. Sens. Marco Rubio, R-Fla., and Susan Collin, R-Maine, called the Continuing Small Business Recovery and Paycheck Protection Program Act. The new rule would allow bankrupt companies to receive PPP funds with the permission of the bankruptcy judge presiding over their cases and would require the loans to be granted superpriority status. This means they will be repaid with the highest priority as an administrative claims against a debtor's estate.

The Rubio-Collins proposal is part of a larger framework of relief bills presented by Senate Republicans last week called the Health, Economic Assistance, Liability Protection and Schools Act, or HEALS Act. An aid package presented by congressional Democrats several weeks ago did not include the PPP changes forwarded by the Republican proposal.

Ted Gavin, managing director and founding partner of turnaround consulting firm Gavin/Solmonese LLC, told Law360 the new bill proposal would do well to eliminate the uncertainty and litigation associated with the PPP denials and requests for injunctions against the SBA that have been bogging down Chapter 11 cases.

"It's probably best that door stays shut," Gavin said of the litigation issues. "You get into all sorts of problematic areas of law that don't normally show up in bankruptcy court. It's better that we fix this."

Going forward, Ramsey thinks some of the debtors who have been denied PPP loans based solely on their bankruptcy status may be able to reapply and receive the funding that would help alleviate its payroll and lease obligations.

The proposal, coupled with changes to the Small Business Reorganization Act adopted earlier this year and augmented by the CARES Act, will save many small enterprises that otherwise would collapse in the current environment, Ramsey said.

The SBRA was changed in February with the addition of the new Subchapter V to reduce the costs associated with filing for Chapter 11 for small businesses with debt under about $2.7 million. The changes streamlined the process and removed certain obligations for these small debtors. The CARES Act itself increased the debt threshold for taking advantage of the Subchapter V process to $7.5 million, opening the door for more struggling small businesses.

Ellias said he is hopeful that the proposal will make it through the legislative process intact and, perhaps, even stronger by the time it reaches the desk of the president. While an earlier bill floated by Democrats in congress didn't include the allowance for debtors to be eligible for PPP loans, he sees no reason why it should be challenged.

His group has pushed to allow debtors to access all of the programs included in the original CARES Act if and when any new relief packages are adopted.

"I think there is a deep understanding from both sides of the aisle on the hill of the value of the bankruptcy system," Ellias said. "Congress recognizes the bankruptcy system is an advantage this country has in trying to move forward from this crisis."

--Editing by Katherine Rautenberg.

For a reprint of this article, please contact reprints@law360.com.

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